Health Care Reform May Impact Fringe Benefits for Nonprofits

“Cap and Trade” will be a focus on Capitol Hill for 2009…but it will pale in comparison to the debate on health care reform. It appears Congress realizes the revenue sources must be identified to fund health care reform. It is not something to be funded by the federal government like another stimulus package. The 10-year cost for revamping the health care system is estimated to exceed $1 trillion. With health care cost savings expected to pick up about 40% of the tab for overhaul, that leaves Congress needing to find more than $600 billion in revenues. You will hear a lot about a possible new consumption tax as a way to foot the bill for health care reform. After carving out exemptions for food, prescription drugs, and maybe housing and utilities, a value added tax (VAT) of perhaps 6% would be required. This is high enough to prompt most officials who want to be reelected to beat a hasty retreat. So, a VAT on top of the income tax does not appear to be in our near future. Another option being considered by taxwriters is to charge a surtax of 2% or more on upper income bracket taxpayers—the same taxpayers targeted by the Administration, letting the 33% and 35% top marginal rates rise to 36% and 39.6%, respectively. Many of the other options under discussion by the Senate and the House would impact the taxability of employer-provided health insurance, the reimbursement of out-of-pocket medical expenses, or the deductibility of unreimbursed medical expenses. Here a few of the options:

• Limiting employer provided health coverage that is excludible form gross income. The limit could be based on the value of the plan or the income of the insured, or the limit could be a combination of both.
• Repealing the tax exclusion for employer-provided health coverage. In exchange for repealing the tax-free benefit for employer provided health insurance, employees would get an extra standard deduction. (For employees who have no income tax liability, such as many pastors, the extra standard deduction would provide no benefit to the taxpayer.)
• Modify or repeal the itemized deduction for medical expenses. The 7.5 percent AGI threshold for the itemized deduction for medical expenses could be raised or eliminated.
• Increasing payroll taxes or levy on employers. This could include raising the Medicare tax from its current 1.45% rate to 1.8% or higher (for the self-employed, this would mean an increase from 2.9% to 3.6%). Another option under discussion is imposing a new payroll tax on employers of 3% or so of the amounts they spend on health care for employees. For employers that do not provide health benefits, one option is to impose a levy of 8% of payroll.
• Modify health savings accounts. HSA contributions could be limited to the lesser of the individual’s deductible under the high deductible health plan or the dollar amount of the maximum allowable aggregate HSA contributions. The additional tax on distributions from an HSA that are not used for qualified medical expenses would be increased to 20 percent. Distributions from an HSA would only be excludible from gross income as an amount used for qualified medical expenses if the expenses are substantiated by the employer or an independent third party.
• Modify or repeal the exclusion for employer-provided reimbursement of medical expenses under flexible spending arrangements and health reimbursement arrangements. A limit would be placed on the amount of salary reduction contributions that may be made to a health FSA that would be excludible from gross income. Alternatively, the exclusion for salary reduction contributions to a health FSA could be eliminated. Similar changes could be made to the exclusion for reimbursements for medical expense under an HRA.
• Limit the qualified medical expense definition. With respect to medicines, the definition of medical expense for purpose of employer plans (HRA’s and FSA’s) and health savings accounts could be conformed to the definition for purposes of the itemized deduction for medical expenses. Thus, for example, the cost of nonprescription medicines would not be reimbursed through a flexible spending arrangement.

The political struggle will probably take months to play out but if some of these options are enacted into law it will bring increased pressure on churches and other Christ-centered organizations…and their staff. Reductions in tax-free benefits means employees have less take-home pay in their pockets. Because of the economic trough we may be in for several years, many churches and other nonprofit organizations will find it difficult to raise salaries to offset benefit reductions. Stay tuned!